March 15, 2011
Dallas, Texas, USA
It’s no secret that the United States government owes a pretty penny to foreigners. Certainly, what America owes to foreigners pales in comparison to what it owes to Ben Bernanke… but still, $4.45 trillion is no small number, even in these crazy times when terms like “kajillion bajillion” are more appropriate to quantify debt and entitlements.
China is the largest foreign buyer of US Treasuries with around $1.15 trillion in holdings… Japan is the second largest at around $886 billion. Curiously, the trend for China has been down– the Middle Kingdom has been steadily reducing its position since peaking in October 2010.
Japan, on the other hand, has been steadily increasing its Treasury holdings over the same period. Its government does have a long pattern of currency intervention, and there has been much grumbling in Tokyo about the effects of the strong yen on their exports.
Fast forward to this past weekend. Earthquake. Tsunami. Volcano. Nuclear radiation. Japan clearly has other things on its mind right now than to continue financing the ongoing largess in Washington DC.
At a minimum, Japan will likely slow (or eliminate) its US Treasury purchases, instead focusing on dumping money into its own economy. At greater risk, Japan may choose to allow much of its Treasury portfolio to simply mature, requiring the US government to repay tens of billions of dollars of principal (which it doesn’t have).
With so much uncertainty, many investors around the world are buying Treasuries at the moment, so if Japan starts selling its portfolio into that momentum, the impact may be negligible… for now. Rearranging the deck chairs, if you will.
Come June 30th, though, with the supposed end of the “I’m not printing money” money printing that is quantitative easing, the US government will have lost, in theory, two of its biggest buyers– the Federal Reserve and Japan. And with both China and the OPEC nations slashing their own Treasury purchases, it leaves one simple question:
Who will buy all of this US government debt?
Below are some of the possible outlets:
1) US commercial banks. They’re awash with cash and partially owned by the government anyhow. The Treasury department could easily influence banks to increase their net bond purchases. This would have the effect of crowding out (once again) small businesses and individuals’ access to credit.
2) Retirement accounts. There’s $5 trillion of fresh meat available in US retirement accounts. It would be nothing for the Congress to pass a law requiring money managers to allocate a portion of their onshore retirement accounts to the ‘safety and security’ of US Treasuries. Kiss your retirement savings’ purchasing power goodbye.
3) Higher taxes. This is a given, unfortunately. It’s erroneous to conclude that higher tax rates yield higher tax revenues– yet this is the standard mantra of politicians. Higher tax rates reduce incentives to invest, take risks, and create wealth. Economic activity falls.
4) Default. Paint China as the root of all evil, the real reason behind America’s financial decline. Find a plausible reason to single out China and default on the debt that they own. I think this is possible down the road, but it would take a few years of preparatory political jockeying to pull off. What’s more likely is….
5) QE3. It’s coming back, like a bad Stallone franchise that just won’t go away. The lender of last resort will once again be the last resort… for the US government.
After a brief period of dollar strength from reduced risk tolerance, investors will realize that the world ex-Japan did not, in fact, come to an end… and they will resume the long-term trend of selling dollars for precious metals and more stable currencies (Australia, Singapore, and possibly even Japan).
The next few months may prove to be the best (and last) time to get out of the dollar.